BMR: A Regulatory Spotlight on Benchmarks

BMR: A Regulatory Spotlight on Benchmarks

By Sean Tuffy, Head of Market and Regulatory Intelligence, EMEA, Custody & Fund Services at Citi
Originally published in Citi’s Caught in the E.U. Finreg Wave

Regardless of their location, asset managers must now add European benchmark compliance to their risk and control processes.

In response to several benchmark manipulation scandals, the E.U.’s Benchmark Regulation (BMR) came into force January 2018. The BMR sets a new global standard in the regulation of benchmarks by introducing strict guidelines for E.U. benchmark administrators, contributors, and users. The goals of the BMR are to improve governance over the benchmark process, mitigate conflicts of interest, and to improve the quality of data and methodologies used by benchmark administrators.

Under the BMR, E.U. benchmark administrators must be authorized by their national regulators. The European Securities and Market Authority (ESMA) maintains a register of all authorized benchmark administrators in the E.U.

Existing E.U. benchmark administrators have a two-year transition period to apply for authorization or registration. However, they are expected to comply with the BMR while seeking authorization.

ASSET MANAGEMENT IMPACT

While the primary focus of the BMR is on the benchmark administrators, it also impacts E.U. asset managers and funds. If asset managers use an index to measure performance, set portfolio allocations, or calculate performance fees then it qualifies as a benchmark user. Under BMR, E.U. benchmark users are required to use only BMR compliant benchmarks.

To comply with BMR asset managers must:

1. Have a process in place to track their benchmarks usage

2. Disclose in their funds’ prospectuses and offering documents that all appointed benchmark administrators are included on ESMA’s approved register

3. Maintain a written contingency plan in the event that a benchmark is no longer available

While the BMR does not directly apply to non-E.U. asset managers, indirectly it impacts their risk management processes. Like their European counterparts, non-E.U. asset managers should ensure that any E.U. benchmark administrator they use is BMR compliant and have a contingency plan in place. Failure to so could result in non-E.U. asset managers losing access to a benchmark which could have serious implications for funds, such as the inability to measure performance or set portfolio allocations.

Regardless of their location, asset managers must now add BMR compliance to their risk and control processes.

INTERNATIONAL IMPLICATIONS

The BMR has a direct impact on all non-E.U. benchmarks because E.U. financial firms can only use non-E.U. benchmarks if they have been approved by ESMA. Non-E.U. benchmark administrators have until 2020 to be granted approval by ESMA. There are three ways that a non-E.U. benchmark provider can be approved for use.

Equivalence
A non-E.U. benchmark’s country can be deemed to have equivalent regulations to the BMR. This will be a tough needle to thread because, currently, no other jurisdiction has regulated benchmark administrators in the same way.

Endorsement
An E.U. benchmark administrator can endorse the benchmark provided in a non-E.U. country. This may be a viable option for global benchmark operators that have operations in the E.U.

Direct Authorization
A non-E.U. benchmark can seek direct authorization from an E.U. member state’s regulator. This would entail becoming directly regulated by the E.U. regulator, in addition to the non-E.U. benchmark’s home regulator. The U.K.’s pending withdrawal from the E.U. adds an extra dimension to the non-E.U. benchmark issue. When it leaves the E.U., all U.K.-based benchmark administrators will need to seek authorization as a nonadministrator. However, work cannot be done on this until the Brexit negotiations are completed. The industry must keep a close eye on developments and update their contingency plans accordingly.

THE OUTSTANDING QUESTION

One big question remains: How will non-E.U. benchmarks get approval from ESMA? All of the available routes to recognition have their challenges and, so far, a preferred option has not emerged. While 2020 is still a while a way; E.U. firms should pay close attention to developments and have a “plan B” ready, just in case their non-E.U. benchmarks fail to clear the equivalence bar.